If you’re a contractor, you’ll hear a lot about IR35, and when it comes to determining your status, you need to know whether your contract work falls ‘inside’ or ‘outside’. But what does this mean, and why does it matter?
We’ll break down exactly what IR35 is, and why it’s crucial to have your status determined when you begin to collaborate with your clients.
What is IR35 and how did it come about?
Before IR35, employees could switch from employment to their own limited company in a flash, with no changes to their working dynamic.
While that may seem pointless from the outside looking in, it meant the employee could pay themselves a smaller salary and the rest in dividends, saving themselves tax, and leaving more money in their pocket.
It benefited the employer too, now they no longer had to pay Employers’ National Insurance or pension contributions for their employee; it was as simple as paying an invoice at the end of each month.
HMRC deemed this ‘disguised employment,’ which means you’re working in the same way as a traditional employee, but doing so through a limited company.
In their eyes, being a disguised employee meant you were underpaying tax and NI due to your company status, so to stop this, IR35 was born. The rules first came into effect in 2000.
Subsequently, new ‘off-payroll working rules’ were also unveiled in 2017 and 2021, which made clients responsible for working out whether a contractor is inside or outside IR35. Beforehand, contractors could self-certify their status.
If you’re seen as a disguised employee, your contract work is said to be ‘inside’ IR35.
Why does it matter whether I’m inside or outside IR35?
The way you pay your taxes and run your business will differ depending on your IR35 status.
If you’re ‘inside’ of IR35, you’ll have both National Insurance and tax deducted from your pay each month by your client (like PAYE).
This makes you almost identical to an employee, but you may find you aren’t entitled to annual leave, and you won’t receive the safety net of redundancy pay like a regular employee.
This also means you’ll no longer be able to pay yourself a smaller salary and the rest in dividends, because your client will deduct tax and NI from your invoice instead.
For this reason, some contractors ensure they remain outside of IR35 to run their business as normal. That is if you are able to find contract work which is advertised as ‘outside IR35’.
Always ensure your status is checked regularly. If HMRC has reason to believe your status is incorrect, they can launch an investigation.
Who is responsible for checking my IR35 status?
It’s up to your client to decide whether you’re inside or outside of IR35, in a process known as ‘determining status’.
Your client will complete an assessment and provide you with an SDS (Status Determination Statement), which states whether you’re inside or outside IR35.
The only time you or your agency will determine your own status is if you ever work with a small company. To be considered a small company they will need to satisfy at least 2 out of 3 of the following conditions:
- An annual turnover of £10.2 million or less
- A balance sheet total of £5.1 million or less
- Have 50 employees or fewer
What if I have clients both inside and outside IR35?
Having a mix of the two can be common, and straightforward to manage. You don’t need to worry about your contracts inside of IR35, because income tax and NI are deducted from your pay by the client.
Anything outside IR35 is managed as normal through your limited company. This means you’re still entitled to take dividends on the income made via outside IR35 work.
If you have no clients outside of IR35, you might decide to set your company as dormant until you’ve finished your current projects.
Can I appeal against my IR35 status?
If you and your client disagree about your status, you can appeal against it. There are a few steps you’ll need to complete, including:
- Outline the parts of your determination status you disagree with.
- Let them know specifically why you disagree with their decision, for example, you believe you provide a specialist service and charge set fees.
- Allow a maximum of 45 days for them to reply and record all communication.
The Bottom Line
It’s important to ensure your status is correctly determined with all your clients, and that you pay any tax correctly.
If your contract work is later deemed to be inside IR35, you’ll need to pay the tax and NI you owe, plus any interest to HMRC.
This guide was written by Rachael Johnston – Content Marketing Executive at The Accountancy Partnership.
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